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After this course on quantitative finance with R, you will be able to use R to develop a model to value a fixed interest rate bond, estimate and analyze a bond's yield (i.e., a measure of the opportunity cost of bond investors), and model techniques used to protect bond portfolios from changes in interest rates.
Why value bonds?
Bonds are securities issued by governments or corporations that pay interest over a fixed schedule and are the most well-known type of fixed income securities. The US fixed income market is 1.5x larger than the US stock market, but, unlike stocks, most fixed income instruments, including bonds, trade very infrequently. Consequently, a bond's price may be a less reliable indicator of its value and analytical techniques are necessary when analyzing and valuing bonds.
Introduction and Plain Vanilla Bond ValuationFree
The fixed income market is large and filled with complex instruments. In this course, we focus on plain vanilla bonds to build solid fundamentals you will need to tackle more complex fixed income instruments. In this chapter, we demonstrate the mechanics of valuing bonds by focusing on an annual coupon, fixed rate, fixed maturity, and option-free bond.Introduction50 xpPrice vs. value50 xpTime value of money50 xpComputing a bond's future value100 xpComputing a bond's present value100 xpBond valuation50 xpLaying out the bond's cash flows100 xpDiscounting bond cash flows with a known yield100 xpConvert your code into a function50 xpConvert your code into a bond valuation function100 xp
Yield to Maturity
Estimating Yield To Maturity - The YTM measures the expected return to bond investors if they hold the bond until maturity. This number summarizes the compensation investors demand for the risk they are bearing by investing in a particular bond. We will discuss how one can estimate YTM of a bond.Price-yield relationship50 xpCredit ratings50 xpThe yield on the Moody's Baa index100 xpValue the 5% bond using the Baa yield you found100 xpPlotting the price/yield relationship100 xpComponents of yield50 xpRisk-free yield50 xpPlotting US Treasury yields100 xpPlotting the investment grade spread100 xpEstimating the yield of a bond50 xpFinding a bond's yield100 xpUse uniroot function to find YTM100 xp
Duration and Convexity
Interest rate risk is the biggest risk that bond investors face. When interest rates rise, bond prices fall. Because of this, much attention is paid to how sensitive a particular bond's price is to changes in interest rates. In this chapter, we start the discussion with a simple measure of bond price volatility - the Price Value of a Basis Point. Then, we discuss duration and convexity, which are two common measures that are used to manage interest rate risk.Bond price volatility and the price value of a basis point50 xpPrice value of a basis point50 xpCalculate PV01 of a 10% bond100 xpDuration50 xpDuration of a zero-coupon bond50 xpCalculate approximate duration for a bond100 xpEstimating effect on bond price using duration100 xpConvexity50 xpCalculate approximate convexity for a bond100 xpEstimating effect of convexity on bond price100 xpEstimating the bond price using duration and convexity100 xp
We will put all of the techniques that the student has learned from Chapters One through Three into one comprehensive example. The student will be asked to value a bond by using the yield on a comparable bond and estimate the bond's duration and convexity.Summarizing the main lessons50 xpFind AAA bond yields as of September 30, 2016100 xpBond valuation100 xpAlternative cash flow vector code100 xpDuration and convexity50 xpDirection of price change50 xpCalculate duration100 xpCalculate convexity measure100 xpThe estimated price change using duration and convexity100 xpCongratulations!50 xp
PrerequisitesImporting and Managing Financial Data in R
Vice President at Compass Lexecon
Clifford S. Ang, CFA is a Vice President at Compass Lexecon. He specializes in valuation, corporate finance, and damages, and has worked on hundreds of engagements involving companies across a broad spectrum of industries. He is the author of Analyzing Financial Data and Implementing Financial Models Using R.